Posted | by David Moenning |
Early Warning Wednesday for 7.15.20: It's Complicated image

Good Morning. Since it's Wednesday, it's time to review our Early Warning indicator boards.

The Process: Once we have identified the state of the big-picture environment, the current trend, and the degree of momentum behind the move, we then look at the potential for a countertrend move to develop. This batch of indicators is designed to suggest when the "table is set" for the trend to "go the other way."


* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability - NOT INDIVIDUAL INVESTMENT ADVICE.
View Early Warning Indicator Board Online

My Take...

The Early Warning board continues to be a mixed bag as neither team appears to hold an edge at the present time. This probably sounds a little odd given that a great many analysts consider the current market to be very overbought. However, the current situation is complicated. From my seat is important to recognize that we are dealing with a bifurcated market, in which the major indices (save the NASDAQ) have been stuck in a trading range while the NASDAQ Composite and NASDAQ 100 indices have been on an impressive roll and are indeed overbought - and due for a rest. So, while the table may be set for a pause in the NDX, the bulls would appear to have some room to run in the S&P 500, and especially in the indices that require an economic recovery to work such as the DJIA, Russell 2000, Midcaps, etc.

Stochastic Review

Over the years, I have found that reviewing the basic stochastics is perhaps the simplest way to determine when an index or security may be ripe to "go the other way" for a while. I like to keep it simple here by using a 14 day %K (with 1 day smoothing) and a 3 day %D. It's not fancy, but it tends to be an effective tool that I rely on.

S&P 500 - Daily

View Larger Chart

In the chart above, it is clear that the stochastics remain in overbought territory. However, it appears that a "good overbought" condition is developing. As opposed to a traditional overbought condition, which tends to lead to countertrend moves, a "good overbought" condition is where a market "gets overbought and stays overbought." The bottom line is I see this as a "rally continuation" sign which tends to have bullish tendencies. So, unless the bears can get something going quickly, my take is that we now have a "good overbought" condition on our hands.

Thought For The Day:

"Never ascribe to malice, that which can be explained by incompetence." --Napoleon

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

Early Warning Models Explained

Short-Term Overbought/sold Indicator: This indicator is the current reading of the 14,1,3 stochastic oscillator. When the oscillator is above 80 and the %K is above the %D, the indicator gives an overbought reading. Conversely, when the oscillator is below 20 and %K is below its %D, the indicator is oversold.

Intermediate-Term Overbought/sold Indicator: This indicator is a 40-day RSI reading. When above 57.5, the indicator is considered overbought and wnen below 45 it is oversold.

Mean Reversion Model: This is a diffusion model consisting of five indicators that can produce buy and sell signals based on overbought/sold conditions.

VIX Indicator: This indicators looks at the current reading of the VIX relative to a series of Donchian Channel bands. When the indicator reaches an extreme reading in either direction, it is an indication that a market trend could reverse in the near-term.

Short-Term Sentiment Indicator: This is a model-of-models composed of 18 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a short-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Intermediate-Term Sentiment Indicator: This is a model-of-models composed of 7 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a intermediate-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Long-Term Sentiment Indicator: This is a model-of-models composed of 6 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a long-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

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